Central banks begin gaming out U.S. default as deadline nears

Global central banks have begun forming contingency plans on how they would keep financial markets working if the U.S. defaults on the world’s benchmark debt.

Policy makers discussed possible responses when they met at the International Monetary Fund’s annual meetings in Washington over the weekend, said officials who spoke on condition of anonymity because the talks were confidential. The discussions continued as policy makers headed home.

“Because in the past it’s always been sorted out is absolutely not a reason to fail to do the contingency planning,” Jon Cunliffe, who joins the Bank of England as deputy governor for financial stability next month, said in testimony to U.K. lawmakers today. “I would expect the Bank of England to be planning for it. I’d expect private-sector actors to be doing that, and in other countries as well.”

The initial response from the world’s central banks would likely echo that witnessed in the wake of the collapse of Lehman Brothers Holdings Inc. in 2008. Back then, policy makers pledged they they would provide ample liquidity, eased the collateral they leant against and boosted dollar swap lines with each other to ensure supply of the currency.

The $12 trillion of outstanding U.S. government debt is 23 times the $517 billion Lehman owed when it filed for bankruptcy on Sept. 15, 2008.

Maintain Plumbing

“You want the plumbing of the financial sector to keep working even with the main benchmark in default,” said Rob Wood, an economist at Berenberg Bank in London and a former official at the Bank of England. “You want to avoid a firesale of U.S. assets.”

Time is running short for U.S. politicians as they try to end a political stalemate that’s threatening to push the nation into default if the government’s borrowing authority isn’t raised before Oct. 17. President Barack Obama postponed a 3 p.m. meeting with Congressional leaders today to “allow leaders in the Senate time to continue making important progress” toward a deal, according to White House statement.

While policy makers from Japan to Saudi Arabia have expressed faith in the ability of the U.S. to pay its bills, a default would put the world in uncharted territory.

Central bankers have spent the last six years expanding their toolkit to deal with a financial crisis that began in August 2007 when tremors in the U.S. subprime mortgage market began reverberating worldwide. That turmoil deepened with the Lehman failure and was then extended by Europe’s fiscal woes.